- The Washington Times - Tuesday, May 9, 2006

If, as expected, the Federal Reserve’s policy-making committee raises its short-term target interest rate another quarter-point today, it will mark the 16th consecutive policy meeting over the past two years at which the Fed has taken that precise action. In June 2004, when the Fed began raising the federal-funds rate, that target interest rate stood at 1 percent. Today, it will almost certainly reach 5 percent. Fed Chairman Ben Bernanke recently told the congressional Joint Economic Committee that the Fed “may decide to take no action at one or more meetings in the interest of allowing more time to receive information relevant to the outlook.” He hastened to add that the Fed “will not hesitate to act when it determines that doing so is needed to foster the achievement of the Federal Reserve’s mandated objectives.”

Given the time lags during which changes in monetary policy slowly and cumulatively work their way through the economy and given the fact that the target rate will have been raised 4 percentage points over two years, it is understandable why the Fed “at some point in the future,” in Mr. Bernanke’s words, would consider pausing. We certainly do not interpret his remarks to signal dovish intentions on the inflation front.

Despite the Fed’s tightening, inflationary pressures continue to manifest themselves. Oil prices have recently reached $75 per barrel. Consumer price inflation has increased from 3.4 percent during 2005 to a seasonally adjusted annual rate of 4.3 percent during the first quarter. After jumping 17 percent last year, energy prices advanced at a 22 percent annual rate in the January-March period. Also, the danger of energy-price inflation passing through to other goods appears to have intensified in recent months. The core consumer price index (CPI), which excludes the volatile food and energy sectors, increased at a seasonally adjusted annual rate of 2.8 percent during the first quarter; that was more than half a percentage point higher than the core CPI increased during 2005.

Moreover, a number of conditions exist whereby inflationary pressures can easily accelerate and feed upon themselves. The real economy has been growing at an annual rate of roughly 5 percent so far this year. The labor market continues to tighten as the unemployment rate has declined to 4.7 percent. Industry’s capacity-utilization rate is steadily climbing. And the dollar has been depreciating this year, adding further inflationary pressures to the domestic economy. Meanwhile, fiscal policy remains extraordinarily expansive for this stage of the business cycle. With or without a pause, it appears that the Fed has not yet completed its tightening cycle, even after its expected rate increase today.

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